The Charitable Lead Trust

THE COUNSELOR

Volume 3 • Issue 5 • June 2013

The Counselor is a monthly newsletter of Hallock & Hallock dedicated to providing useful information on estate planning, business planning and charitable planning issues. This is the second in a series of articles on charitable planning strategies. In this month's issue, we will look at the Charitable Lead Trust. If you are interested in learning more about the ideas discussed in this newsletter, please contact us for a free initial consultation.

Another common tool for planned giving is the Charitable Lead Trust, or CLT. A CLT is established to provide income payments to one or more charitable organizations for a fixed period of years, after which, trust assets are paid to either the grantor or to one or more non-charitable beneficiaries named in the trust. While CLTs are often thought of as the inverse of the Charitable Remainder Trust, the rules that govern the operation and taxation of CLTs differ significantly. CLTs are a useful way to make a lifetime or testamentary gift at a reduced (or zero) gift or estate tax cost.

How CLTs Work

The donor transfers assets to a trust for a set term of years. Each year, payments are made from the trust to the designated charity or charities. Once the trust's term expires, what is left goes to the donor's heirs. Similar to a Charitable Remainder Trust, the payment from a CLT come in two varieties, unitrust or annuity. The Charitable Lead Unitrust (CLUT) calculates the income interest to charity as an amount equal to a fixed percentage of the net fair market value of the trust assets as determined annually. A Charitable Lead Annuity Trust (CLAT) pays “a determinable amount” at least annually to the charitable beneficiary. Unlike a Charitable Remainder Trust, there is no minimum five percent (5%) payout requirement on a CLT. CLTs may be taxed as grantor or non-grantor trusts and may be inter-vivos (established during life) or testamentary (trusts established at death) trusts. Generally, a testamentary CLAT works best in attempting to zero out any estate taxes.

The Benefit

The charity benefits by receiving a reliable stream of income for as long as the trust lasts. The donor benefits in that any leftover assets are transferred to the remainder beneficiaries free of federal gift and estate tax. The property contributed to a CLT is assumed to grow at a rate equal to the 7520 rate in effect at the time of the transfer (or, if lower, the grantor may elect to use the 7520 rate in effect in either of the two preceding months). A CLT works best in a low interest rate environment because any investment performance in excess of the 7520 rate passes tax free to family members at the end of the trust’s term. For this reason, the rate is often referred to as the "hurdle" rate. The rate remains locked in for the length of the trust.

An Example:

Father puts $1,000,000.00 in a twenty year CLT to benefit Charity. The trust stipulates that Charity is to receive $50,000.00 in income annually. At the end of the twenty year term, Son is to receive the trust principal. For gift tax purposes, only the present value of the remainder interest (what the IRS estimates the value of the trust principal will be at the end of the trust period) is subject to tax. Using the June 2013 7520 rate of 1.2%, the taxable amount is $111,160.00 and the exempt amount is $888,340. Assume a 6% annual return on the trust principal - which actually grows to about $1,320,000.00 (what Son receives). The difference between the value of the remainder interest and the actual trust value at the end of the trust term (about $1,208,840.00) passes to Son free of transfer taxes.

The Risks

There are some downsides to CLTs. Some of the downsides include:

CLTs are irrevocable and once the assets are contributed, they cannot be taken back out.

If the value of the assets decreases, the amount left could be less than anticipated.

The trust must make its charitable payment no matter what the market is doing.

The gift to the ultimate beneficiaries must be delayed for a period of time.

Conclusion

As with other types of advanced planned giving, CLTs come in multiple varieties to meet specific goals and objectives. The planning can be complex and at times aggressive. Because of the complexities, to engage in this type of planning, competent counsel should be sought from the outset and continued for the duration of the trust. CLTs can be a great vehicle to take advantage of the confluence of continuing low interest rates and high gift and estate tax exemptions. The environment for CLT planning becomes a perfect storm if you anticipate strong growth in the assets being contributed to the trust. CLTs can be a great tool to meet your planning needs and your desired charitable intentions.

This Newsletter is for informational purposes only and not for the purpose of providing legal advice. You should contact an attorney to obtain advice with respect to any particular issue or problem. Nothing herein creates an attorney-client relationship between Hallock & Hallock and the reader.